The international revenue data on the exhibit includes only the amount received by HKT as a result of the agreement by which it receives 40% of revenues from each overseas call (60% in the case of calls to South China). The cost figures are based on data provided by HKT, which show operating costs of HK$197 million attributable to international calls and HK$1,332 million to the operation of the local network; the total is HK$1,529 million. HKT also calculates an amount of HK$30 million as attributable to the use of the local network for carrying international calls; however since only 1.4% of call minutes are international, and variable costs make up only a part of the total local network cost, the true amount attributable to such use is negligible. For example, even if as much as 40% of the local network costs were deemed variable (a very high estimate in view of the fact that most of the local network investment is in customer lines), the cost of each of the 18,000 million local call minutes made annually is only HK$0.03 (HK$1,332 million times 40% divided by 18,000 million). The cost of the 252 million international call minutes is then HK$7.5 million (252 million times HK$0.03). We do not attempt to distinguish on Exhibit 5.11 between fixed and variable cost in the local network.
From the data on Exhibit 5.11 we can deduce that there is in fact a cross subsidy between international and local calls. On a purely operating cost basis, local revenues (for business and residential line rental) cover costs with a margin of HK$40 million per year, or 3% over costs. However in order to produce a return to shareholders of 16% per year, a much larger margin is required. A telephone company typically has a capital base in respect of non-international operations very roughly equal in value to two year's of revenue. This implies that a 16% return on invested capital requires a 32% margin of revenues over costs. A 32% margin over costs of HK$1,529 million would yield revenues of HK$2,018 million. The actual revenue figure of HK$2,170, and corresponding margin over operating costs of 42%, reflects the different ratio between assets and turnover applying in Hong Kong and also the need to provide for capital financing costs.
Redistributing this 42% margin between the local and international service yields the following data on profitability of the two services:
HK$ million per year
International
Service
Local Service
Operating costs
197
1,332
Operating costs plus 42% margin.
279
1,891
Revenues
798
1,372
Net contribution (receipt) from cross subsidy
519
(519)
133